How the defence pension bill became a big burden
In December 2019, nearly 800,000 French citizens protested and disrupted vital services. They were opposing a pension reform with a limited aim of consolidating 42 different pension schemes into a universal points-based system. In September 2018, thousands of Russians protested a reform that increased the retirement age. Russian President Vladimir Putin’s approval rating fell by nearly 10%, and he rolled back the hike partially in the retirement age for women. These two instances illustrate that pension reform is a wicked public policy problem. India’s defence pension problem is no exception.
Defence pensions comprised 26.4% of the defence ministry’s budget in FY21, up from 18% a decade ago. The increase in the pension bill resulted in an equivalent decline in the capital procurement budget. With the implementation of the One Rank One Pension (OROP) scheme, it became clear that pension expenditure will keep growing faster than all other components of the defence budget. While the stated objective of the recently announced Agnipath scheme tries to distance itself from the pension problem, it doesn’t hide the fact that containing the spending on salaries and pensions is an underlying motivator for this reform.
The history of this burgeoning defence pension bill has valuable lessons for policymaking. Here’s how India’s defence pension bill became a financial burden.
Before 1965, soldiers below officer ranks were recruited through a mechanism resembling Agnipath, in the sense that they served seven years of compulsory service and didn’t receive a pension on retirement. This service period was first raised in 1965 to 10 years for bulking up the armed forces after the 1962 defeat. Since a pension required a minimum service of 15 years — most soldiers still didn’t qualify. In 1976, this 10-year service term increased to 17 years, meaning every soldier in normal circumstances qualified for a pension on retirement. With the welcome development of rising life expectancy, there was also a steady increase in the number of pensioners. The combined effect of these factors was a rapid rise in the pension bill. From ₹228 crore in FY81, the pension expenditure galloped to ₹5,923 crore by FY99.
The Kargil Review Committee (1999) set off alarm bells over the pension issue, mooting the idea of reducing the service term to seven to 10 years. As an alternative, the committee also proposed an inverse lateral induction mechanism, whereby a paramilitary force recruit would be deputed to the armed forces for seven years, and repatriated to the parent organisation after that. Through this mechanism, experienced soldiers could be retained in the national security system longer while reducing the pension bill. None of these alternatives received a political nod.
Meanwhile, in 2004, the Union government was able to find a long-term solution for pensioners from the civil services cadre. While continuing to pay pensions to all current employees, the government moved its incoming employees recruited after January 1, 2004, to the National Pension System (NPS). NPS is a “defined contribution” scheme, where the pension is paid out of a corpus the employee and the government co-create over the employment period.
Over time, this move will likely make the pension bill sustainable, as the liability is not being passed on exclusively to future taxpayers. However, armed forces personnel were kept out of this reform, mainly because non-officer rank soldiers retiring after a short 15-year service would not be able to build a robust corpus, unlike their civilian counterparts who were in service for twice that period.
The lost opportunity in 2004 proved to be costly. By 2014, the public discourse had shifted in the opposite direction. Rather than customise the NPS to soldiers’ requirements — which would have been an ideal long-term solution — the National Democratic Alliance government implemented the OROP scheme. By agreeing to a defined benefit scheme that resets periodically based on current employee compensation, the Union government unthinkingly committed itself to a perpetually fast growing liability.
While the government was happy to kick the can down the road, the Covid-19 pandemic was a wake-up call. On the one hand, government finances were thrown off balance. On the other, the border stand-off with China drove home the point that defence reforms were not just essential, but also urgent. The creation of the Chief of Defence Staff (CDS) position was the first step. The late General Bipin Rawat repeatedly drew attention to the unsustainable defence pensions. During his tenure, a few alternatives were discussed. However, each available option came with its own set of implementation challenges. Out of this imperfect set, the government chose to reduce the default service term to four years, labelling it as the Agnipath scheme.
This short history of defence pensions has two important lessons for public policy. First is the need for ex-ante fiscal projections of government plans. Seemingly innocuous changes in pension policies can have hard-to-reverse adverse effects. An institution such as an independent fiscal council can help the people and politicians understand the financial consequences of such plans before they are implemented.
Second, pension reforms are like six-day Test matches. Reducing employees’ pension in service would be an immoral breach of trust. And hence, the reform option can only tackle future employees. Moreover, reforms carried out today can, at best, contain the rise in spending a couple of decades later. Hence, it is imperative to exercise caution on pension policies at the inception stage.